Most business leaders are conscious of what the economic slowdown could do to their businesses. At least two-thirds of the respondents to our survey expect their revenues to decline, and half of them expect the hit to be up to 20%. Similarly, at least two-thirds of our respondents expect profitability to be eroded, with more than half of them expecting the fall in profits to be upwards of 5%.
What does this mean?
Does this reflect operational and cash flow risks? We looked at the interest coverage ratio (ICR) which gives an indication of the ability of companies to cover their interest costs with operating cash flows (graph 1). An ICR greater than one indicates that the operating cash flow of the company is more than sufficient to pay off the interest burden the company has. The interest coverage ratios have declined steeply (in comparison with steady state benchmarks over 2005-08) across sectors, largely driven by falling revenues and operating profit margins. However, going forward, the respondents expect the ICR to drop further (considering the drop in revenue and profit margin and no increase in debt levels). It is interesting that only 27% expect to face cash flow risks—an ICR of 5.6 or so is no a cause for concern (graph 2).
Also See Graph 1: Cautious Outlook (Graphic)
Nor is this cause for concern at a micro level. Still, the drop in revenue and operating profit does manifest itself in a substantial value erosion. To provide some perspective, this erosion is around 10% of our GDP.
Seven out of 10 companies see the economic situation as being the right time to bring about much needed change in ingrained structures and behaviours that may tend to sap productivity and effectiveness. This makes sense. Typically, when there is heady growth, many organizations tend not to get distracted by things such as efficiency and bottom line economic value-added (EVA) improvements. This tends to foster behaviour that may require change while facing a downturn. It is quite exciting to ride the growth trajectory, particularly a levered one on its upside.
However, the downside unleashes a tsunami that takes a huge toll. Moreover, while people are apprehensive and uncertain about future outcomes, it is much easier to provide much required clarity and guide the change.
Better, timely monitoring
In the current economic environment, 61% of the business leaders surveyed said they meet more frequently to monitor business drivers. Senior executives are becoming more “hands-on” than ever before and focusing on key value drivers or thinking of solutions to best guide the business through choppy waters.
Illustration: Jayachandran / Mint
Of the business leaders surveyed, 57% suggest a need to improve the skill sets of business managers to better respond to the environment —more specifically, to improve the focus on balance sheet, and to make right trade-offs to deliver better value. Alignment and synchronous responses are a hallmark of a winning company and strengthening this could be one of the factors that separates winners from the rest.
Traditional planning is passé
Three quarters of the respondents say that traditional planning is passé. There is a clear need to generate “scenarios” that will not necessarily provide an accurate picture of the future, but will give executives better contextual awareness, clarity, and confidence to evaluate multiple action plans they need to respond to the scenarios as they unfold. This is easier said than done, and it will be interesting to see which businesses are able to walk their talk.
Similarly, while many businesses recognize capital planning and its utilization as a key driver in value creation, not many have actually used this to its full ability. And 73% suggest that their processes of capital planning, decision making and follow-through are quite robust.
Also See Graph 2: Interest Coverage Ratio (Graphic)
However, our previous study has found out that about 63% companies of India have destroyed value due to their imprudent use and utilization of capital (see “Are Indian companies back to where it all began?” published in Mint on 23 February). There is room for introspection for businesses to better review their investment decisions—while many may tend to throw out the baby with the bath water in such times and freeze investments, the better ones will tend to utilize this as an opportunity to critically evaluate their investment decisions and refine the processes to do so.
Also See Graph 3: Liquidity Concerns (Graphic)
While the effects of a credit crunch are visible here, India is better off than many other countries. Around 47% of the respondents expect a limited access to capital, and around 34% say that the costs of capital are going to be higher. Equity capital, both public and private seems to have virtually dried up. But debt capital, either for short term or long term is relatively easily available (graph 3).
Unlike some of the other economies, where the banking sector is on a ventilator, Indian banks are continuing to lend money against reasonable collateral and the mortgage market is working quite well too. The cost of money is an issue, however, although there is liquidity and sources of credit in India are much better than other economies.
In the last part of this series, we will look at what business leaders expect from the government and a template on how companies should react to the downturn.
Sanjay Kulkarni is head of management consultant Stern Stewart’s Indian operations. Your comments are welcome at firstname.lastname@example.org